ISHIKAWAJMA-HARIMA HEAVY INDUSTRIES LTD V. DIRECTOR OF INCOME TAX, MUMBAI  RD-SC 8 (4 January 2007)
Tax considerations toreduce the local taxes by a split of the contracts.
Lump Sum Turn Key Agreement Building Building Delivery of Delivery of Engineering Engineering construction construction components components Erection and Erection and Erection control // Erection control Start-up // initial Start-up initial assembling assembling site supervision site supervision operation operation• Turn key vs. component agreement ✓Test runs successfully completed ✓Interface and timing risks ✓Fit for purpose• FIDIC book master agreements ✓One combined package of contracts ✓Consistent and integrated provisions
Legal Structure Offshore Sub Local Sub Chinese Sub Contractor Contractor Contractor Offshore• Lump Sum Turn Key Prime ✓Engineering Contractor ✓Building construction • Exposes entire ✓Delivery of components contract revenue to ✓Erection & assembling tax ✓Site supervision ✓Start-up & initial op Local Principal
Tax Implications of the Agreement• Tax inefficiencies arising from a single consolidated contract for the entire work and lump sum price ✓Under Local/German DTT sale of goods does not constitute a PE, but in case of combined LSTK service part of the agreement constitutes a PE for the whole scope of deliveries and services. ✓Under Local tax laws no withholding tax on sale, but in case of combined LSTK withholding tax on the full remuneration amount. ✓Withholding tax can be credited against corporation income tax obligations, if any. ✓Tax cash refund in general possible, but request usually causes in aggressive tax audit.• Risk of adjustment, because less comparable data for mixed agreements.• Importance of duration of construction work? 6 months? 12 months?
Split of the LSTK agreement Local Sub Local Sub German Sub German Sub Chinese Sub Chinese Sub Contractor Contractor Contractor Contractor Contractor Contractor PE of offshore contractor? Local Local German German Onshore Onshore Offshore Offshore - Split of the contract Contractor Contractor Contractor Contractor - Split of the contractors - Syndicated offer Onshore contract - Local engineering Offshore contract - Local components - Offshore design - Erection / and engineering assembling - German - Building construction components - Site supervision - Chinese - Start up & initial op components - Onshore spare-parts - Ownership trans- Local Principal Local Principal - Onshore training ferred outside of Onshore - Offshore spare parts
Umbrella Agreement• Comfort letter of the offshore company to the buyer/employer• Three main functions: ✓to assure that the service provider is financial capable to fulfill its obligations, including penalties and damages claims. ✓to assure that buyer/employer has no problem to address the correct contractual partner for claims and information ✓„horizontal defense“, prevent the contractors from relying on the defaults of the other parties to avoid performing their contractual obligations.• No overruling and modification of service contract by cross-default clause or taking over of service responsibility by seller• Umbrella Agreement should qualify as agreement not to be necessarily disclosed to the tax authorities, because it is irrelevant tax-wise
ConsortiumAgreement• Rights and obligations of each member ✓ Allocation of costs, risks, ✓ Internal chargeback• Secondment Agreements ✓ Transfer of employees ✓ Internal costs allocation• Financing agreements ✓ stand-alone conditions ✓ no collateral in project ✓ no reference to project• Procedures
Tax Implications after the Split• Offshore contract (Purchase part should be conducted by the Local company) ✓Profits are taxed abroad, tax authorities will look for Local PE ✓No withholding tax ✓Local tax authorities will try to reclassify offshore services as royalties• Onshore contract (Service should be rendered by the domestic company or branch (PE)) ✓Under the DTA profits are generally taxed outside of Onshore ✓If there is a PE in Onshore, it will be taxed here ✓Withholding tax of 3%, but deductible against profits ✓Stamp duty, if any, reduced to the service part• Remuneration has to be adjusted to arm‘s length principles (transfer pricing)• Problem: Tax effects of the umbrella agreement
Other Implications• Avoidance of local red tape requirements ✓Foreign Business Licenses ✓Business visa and work permit issues• Commercial imperatives not to be compromised ✓No uneconomic shift of burden, risks and costs from seller side ✓Turnkey character from employer side ✓No cross-default• Availability of all concessions and exemptions for each party
Resumé: Advantages and downsides• Split of LSTK agreement results in tax savings• Local onshore contractor can be affiliate to offshore company or its branch.• Split results in risk transfer which has to be compensated by bridge agreement.• Any assistance fees paid from offshore to onshore contractor might be classified as royalties with a withholding tax rate of 15%.• The art of Splitting the Agreement is more than a handcraft• Additional costs by the involvement of Local onshore partner• Non-tax: Offshore contractor does not need Local Business License• Structure is not in-line with FIDIC books.• Structure has to be agreed by both parties. Local principal will not take over the tax risks.
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